Despite widespread predictions that bond markets would suffer this year from accelerating growth, rising inflation and the withdrawal of central bank stimulus measures, fixed income markets have posted another year of gains: the Bloomberg Barclays Global Aggregate has returned 6.6% so far this year, the best...
performance since 2009. The index has only lost money for investors in four over the past 20 years. Equities have also had a bumper year, especially in the US and Asia – the former, boosted by president Trump’s plans to cut corporate taxes and red tape, while in China and Japan optimism has been sustained by Japan’s return to growth, two decades later, and by China’s avoidance of a so-called hard-landing.
The most equity-like bonds, such as spread sectors, performed best: Emerging Markets (EMs) have posted double-digit gains year-to-date, despite starting 2017 with a sell-off, following Trump’s victory and the new president’s threats to build trade barriers (read more below). Corporate bonds have also provided positive returns, especially High Yield – usually more sensitive to the economy: US High Yield has gained 7.3% so far this year, while Europe’s is up 6.2% and Asia’s, 6.1%.
Europe came out unscathed from a first half dominated by political uncertainty, and confirmed its good growth momentum in the following months. The single market’s currency responded with optimism, despite efforts from the European Central Bank (ECB) to reiterate that the present stimulus still has a long way to go. Developed markets’ central banks sounded more hawkish in general – with the US Federal Reserve (Fed) hiking rates 3 times – but protractedly low inflation, globally, continued to buoy fixed income assets. The new year starts with concerns over high valuations and the withdrawal of central bank stimulus – as it did last year. And exactly as last year, inflation is still to be seen. The Mid-Week Bond Update team thanks you for another year of attention and wishes you all a very happy 2018.
ON THE RISE
Emerging Markets – a turnaround year: EMs suffered one of their biggest sell-offs at the start of the year amid fears that the US would build up trade barriers with China, the biggest EM and a major client to developing countries in South East Asia or even Brazil. The tone, however, softened as the new US administration publicly recognised that a strong dollar could hurt domestic businesses, and Trump and China’s president Xi ended up shaking hands in November in Beijing – a move that markets welcomed with relief. The JP Morgan Global Bond Index (GBI) has gained 8.5% in local currency terms this year, and 14% when translated into US dollars, given the appreciation of leading EM currencies: Eastern Europe’s currencies have gained most, given their proximity with the resurgent Eurozone – home of most of their exports. The polish zloty, for instance, has rallied 21% against the dollar. EMs have also improved on their own merit after successfully cutting inflation – Brazil, in particular, has seen its leading consumer price index plunge to an annualised 2.8%, down from 10.7% only last year. India and Russia have also reduced price growth significantly. Some EM currencies, such as the South African rand, also did well on hopes that the political landscape could improve in 2018. Click here to read Legg Mason’s Annual Outlook and why some of our affiliates say that EMs could continue to offer opportunity.
EMs defy early Trump gravity and shine in 2017
Source: Bloomberg as of 27 Dec. 2017. The Nikkei is Japan’s leading stock market index; the S&P 500 is the Standard & Poor’s 500 Index; sov. Is sovereign; USD is US dollar; GBP is British pound; loc. Is local; corp. is corporate; HY is High Yield. Please see disclaimers for definitions.
Long US Treasuries – inflation mystery winners: Few would have predicted that in a year in which the Fed hiked rates as many as 3 times and a new president fought to put tax cuts and increased infrastructure spending through Congress, good old Treasuries would perform best. The asset class has returned 9.7% over the past 12 months, the best sovereign performance, excluding EMs, among the 33 fixed income asset classes tracked by Mid-Week Bond Update. Treasuries with more than 25 years of maturity gained as inflation, in the US and globally, remained subdued and inflation expectations fell on both sides of the Atlantic. Despite record low unemployment, US wage growth continued to be almost muted, something often attributed to demographic, technological and globalisation factors. The appointment of Jerome Powell to succeed Janet Yellen as Fed chairman also boosted the asset class, on the belief he is keen to continue Yellen’s gradual and cautious approach. Some, such as Brandywine Global, say that a March hike could even be premature – click here to know why.
ON THE SLIDE
US dollar – bringing down the soufflé: After four years of straight gains, the greenback lost 6.4% of its value against leading world currencies this year. Following a sharp boost in November, when investors bet that Trump’s victory would sharply kick-start the US economy, disillusionment began as early as he was sworn in: the president’s lack of specific details in his inaugural speech in January, combined with lacklustre economic data, brought down expectations, boosting Treasuries and keeping inflation expectations at bay. The US yield curve has been flattening since, with the difference between 30 and 10 year US Treasury yields falling to 33 basis points on Dec. 15, the narrowest since 2008. Legg Mason affiliate Western Asset predicted in late 2016 that optimism seemed overdone, and still holds that, in the absence of inflation, growth may continue to be slow and gradual. Click here to read Western Asset Chief Investment Officer Ken Leech’s comparison of the US yield curve to Cassandra, the Greek mythology figure whose predictions were always right, yet never believed.
Reality bites: After the post-election optimism, US dollar and inflation expectations fall in 2017
Source: Bloomberg as of 27 Dec. 2017. Gov is government; infl. Is inflation; exp. Is expectations. Please find definitions in the disclaimer.
Bunds – finally found a floor? It seemed that their appreciation had no end, especially as 10-year yields went well into negative levels last year, but in 2017 German bunds finally reversed, posting an overall negative return of 1.2%, one of the poorest performances in sovereign Europe. The main beneficiary of the ECB’s asset purchase programme (distributed in proportion of each country’s share of the ECB’s capital), bunds have suffered from the ECB’s planned withdrawal of its monetary stimulus – which was reduced, but also extended, this year. Germany’s growth and its leadership of Europe’s positive momentum out-weighed the ECB’s lower-for-longer stimulus policy in 2017.
Source for all data: Bloomberg and Barclays Capital as of 27 Dec. 2017, unless indicated.